Diagnosing China's medical device market

The SARS outbreak in 2003, which cost the Chinese economy about 300 billion CNY, along with new concerns over the deadly Avian flu, have motivated the government of China (GOC) to appropriate millions of new dollars to upgrade its massive healthcare infrastructure. The increased funding will greatly expand opportunities for medical parts processors.

As usual, investment in this huge market poses potential gains and problems for international suppliers.

China''s medical device market has grown at a 20%/yr or better clip since 2000. The market now represents the second-largest Asian market for medical supplies and devices, with imports of medical devices reaching $4.5 billion in 2004.. This blazing rate of growth has made China the fasting-growing medical market in the world.

The market''s growth largely has been driven by two key factors. China''s One Child policy has created a 4-2-1 family structure where four grandparents and two parents are able to invest heavily in healthcare expenditures for their only child. The second factor is China''s rapidly aging population, which will continue to demand ever-greater medical attention-the U.S. Census Bureau estimates that by 2025 over 200 million Chinese will be older than 65.

Nonetheless, foreign medical manufacturers must be prepared to face several challenges in this vast market, particularly the market''s increasingly fierce competition from both foreign and domestic competitors-and consequentially disappointing profit margins. Other drawbacks are familiar, including weak enforcement of intellectual property rights laws and redundant regulatory hurdles, which, despite having improved, remain highly centralized and uncertain.

But despite its problems, the overpowering lure of such a vast and increasingly wealthy pool of healthcare consumers will most likely continue to drive both imports and investment into this market. Processors should keep an eye on it.

China''s healthcare infrastructureChina''s effortsto improve its enormous medical are most apparent in the booming healthcare construction industry, where hospital construction rates jumped from an annual average of 270 new hospitals between the years 1950 and 2000, to a new average annual rate of 519 hospitals from 2000 to 2004.

Despite these impressive construction figures, of China''s roughly 60,000 hospitals, only around 6,000 (located for the most part in large urban areas along the coast) possess operating budgets large enough to purchase imported medical products; and even within this subset most of China''s medical device imports are consumed by the country''s roughly 1000 premier class III hospitals, although China''s other 5000 class II hospitals can afford to import around two-thirds of their equipment.

Class III hospitals benefit from zero tariffs on their medical equipment imports, which naturally facilitates sales. Import duties for most other imported medical equipment are relatively minimal, set at 3.9% since 2005 (down from a peak of 20% in the 1990s). This cost is compounded by a basic value-added tax of 17%, but there has been talk about eliminating all tariffs on imported medical equipment.

Other potential customers include the country''s many university medical centers and research facilities, as well as the large and well-funded network of military healthcare facilities.

While these overall numbers might seem to represent a relatively small customer pool for a country of 1.3 billion citizens, several recent factors should ultimately boost the number of medical imports over the coming years.

First, the SARS outbreak forced the GOC to prioritize the modernization of its medical infrastructure. In 2004 the GOC directed each of its 300 larger cities to rebuild or rehabilitate their Centers of Disease Control (CDC), supplying them with the necessary equipment to ensure an operationally safe and effective work environment, directives that have been only reinforced by the Avian Flu threat.

Second, the 2008 Olympic Games are stimulating investment in Beijing''s many medical facilities. To date, the Beijing Committee for the Games of the XXIX Olympiad (BOCOG), in conjunction with the Beijing Department of Health, have selected four major regional hospitals to be upgraded to meet Western standards, and have plans to establish 82 additional medical stations dedicated to initial and minor medical treatment.

Finally, a strong commitment on the part of the GOC to promote its new urban health insurance initiative, which is funded by mandatory contributions from both employers and employees, has helped boost the number of privately insured individuals to around 140 million. While this figure still leaves around 85% of the Chinese population uninsured, and therefore out of the reach of imported medical technology, the GOC has plans to begin expanding mandatory insurance into rural communities by 2008.

The changing face of China''s industriesChina''s exports of medical devices and equipment, which generally have a significant pricing edge over foreign competition, have been expanding at breakneck speed-growing by 33.7% in the first half of 2005 to reach US$1.632 billion. Mirroring the direction of its medical imports, the majority of Chinese exports, almost 70%, were shipped to the U.S., Japan, and Germany.

Looking at the numbers for the first half of 2005, China''s medical equipment exports to the U.S. reached $384 million, a 26.6% jump over the same period in 2004. Medical exports to Japan during this time hit $281 million-a 25.5% climb from 2004 levels, while exports to Germany totaled $98.7 million.

China''s domestic medical device manufacturing is handled by roughly 10,500 mostly small and medium-sized producers, the majority of whom are still largely state-owned. However, as the number of Chinese device manufacturers expands at an annual rate of 13%, the number of independently controlled and funded producers has grown. All of these domestic producers capture just less than half the domestic medical equipment market with sales revenues estimated at roughly 80 billion CNY in 2004.

While most of China''s medical manufacturers are still primarily focused on the medium- and low-technology segments of the market-often falling well short of the U.S. Food and Drug Administration''s (FDA) Quality System Regulations (QSR)-the focus is changing as the domestic industry slowly consolidates, and foreign producers continue to invest heavily.

GE Healthcare''s November announcement that it intended to invest $37.5 million in the expansion of its Shanghai production facility only continues a pronounced trend in China''s healthcare market where seven of the top 10 Chinese medical equipment exporters were foreign-invested or joint-venture enterprises.

Similarly, as medical giants like GE Healthcare and Johnson & Johnson, which opened its second nonprofit medical science center in Beijing on October 15, expand their R&D facilities, it''s only a matter of time before more advanced production follows.

All of these factors have driven China''s expansion of Class 3 medical device manufacturing in recent years, evidenced by the number of new State Food and Drug Administration (SFDA) registrations for Class 3 medical devices, which jumped 62% to reach 2137 during 2004.

This climb up the production chain has allowed some Chinese manufacturers to aggressively solicit orders from more established companies outside China, or to arrange partnerships that will allow them to piggyback on these firms'' existing marketing networks in other developing countries.

Selling into ChinaThe value of China''s medical device import market in 2004 reached US$4.5 billion, 20% higher than in 2003. Projections for 2005 see the entire Chinese medical market continuing to grow by 15%, putting it on track to exceed $7 billion by year''s end.

Healthy local and national budgets for healthcare, which are estimated to reach or exceed 60 billion to 70 billion CNY, will keep imports flowing in 2006, as it is estimated that 25% to 35% of these budgets will be specifically designated for the procurement of new medical equipment.

A quick look at the number of approved medical device import licenses issued by China''s SFDA paints a clear picture of this growing import market. In 2001, the SFDA approved 1104 medical device import licenses. This number grew to 4029 by 2004, and continued to climb during the first quarter of 2005, when 1200 new applications where approved.

Currently, U.S., Japanese, and European (predominantly German) manufacturers capture most of the country''s medical imports. Although U.S. suppliers currently control the largest share, with around 35% of the market, pricing considerations have trimmed some of this share in recent years. This has no doubt influenced decisions by many U.S. medical equipment firms to expand local production capabilities in China.

While competition and pricing remain tight in China, the medical market for high-end products still remains firmly in the hands of the few well-established market leaders, including GE, Siemens, Phillips, and Toshiba, who, together, held around 95% of the market in 2004. Considering the amount of new investment these firms continue to pump into this market, it is unlikely their dominance will end anytime soon.

Agostino von Hassell [email protected], and Mark Bella [email protected], of the Repton Group LLC (New York).